Five rea­sons why in­vestors are brush­ing off Oc­to­ber’s swoon

Eco­nomic con­di­tions th­ese days are sim­ply great, Peter Hod­son writes.

Calgary Herald - - FINANCIAL POST - Peter Hod­son, CFA, is Founder and Head of Re­search of 5i Re­search Inc., an in­de­pen­dent re­search net­work pro­vid­ing con­flict-free ad­vice to in­di­vid­ual in­vestors.

Well, in­vestors, did you en­joy “Shock­to­ber”? Yes, it was a bru­tal last month in the stock mar­ket, as in­vestors fret­ted about midterm elec­tions, earn­ings and in­ter­est rates.

For a while, it cer­tainly looked like 2008 all over again, with tech stocks post­ing their worst month in nearly a decade.

Pun­dits called for the “end of the bull” and of course all the doom­say­ers were wring­ing their hands with glee. We heard from many in­vestors who were shift­ing to cash, “un­til the mar­ket set­tles down” or “cor­rects dra­mat­i­cally.”

But, as usual, fear took over from re­al­ity.

Even with some big cor­po­rate earn­ings misses, mar­kets even­tu­ally calmed down.

The main drivers of the stock mar­ket — in­ter­est rates and earn­ings — are still pos­i­tive for the mar­ket.

Takeovers con­tinue and div­i­dends keep in­creas­ing. While Oc­to­ber cer­tainly was no fun, for sea­soned (i.e. old) in­vestors like us it was just an­other month.

Here are five rea­sons why in­vestors might not want to worry so much about events in Oc­to­ber.

1) Mar­ket val­u­a­tions are now very rea­son­able

Ac­cord­ing to Fac­tSet, the for­ward 12-month price to earn­ings (P/E) ra­tio for the S&P 500 is now 15.6. This P/E ra­tio is be­low the five-year aver­age (16.4) but above the 10-year aver­age (14.5). With very strong eco­nomic con­di­tions, good cor­po­rate earn­ings growth and lots of div­i­dend in­creases and ac­qui­si­tions, we would not view a 15 P/E as at all ex­ces­sive. There has been lots of chat­ter about the “over­val­ued” stock mar­ket, but it sim­ply is just not the case. Put an­other way, just be­cause a bull mar­ket has run a long time does not au­to­mat­i­cally mean it needs to stop.

2) Eco­nomic con­di­tions are more than just ‘not bad’ — they are great

Un­like in 2008, we do not have a seize-up of credit mar­kets. Em­ploy­ment is at a record. Com­mod­ity prices are not surg­ing. Cor­po­rate earn­ings are solid. Things, sim­ply put, are just not bad at all. Gen­er­ally, the mar­ket re­acts to the econ­omy.

The sharp sell-off in Oc­to­ber sim­ply made lit­tle sense if you look at eco­nomic strength, par­tic­u­larly in the US.

3) In­vestors were re­ally not that scared

While we will never ig­nore mar­ket sig­nals, we sim­ply were not that wor­ried in Oc­to­ber be­cause we were closely watch­ing the VIX, or volatil­ity in­dex. It never breached 30. In 2008, it hit 80. Even in Fe­bru­ary — this year’s other “panic” — it hit 37. In 2011, it hit 48. Thus, in terms of real panic for in­vestors, Oc­to­ber re­ally wasn’t even close to other pan­ics, which of course, all proved to be op­por­tune buy­ing times (as panic usu­ally is).

4) Money still came into the mar­ket

We like Van­guard ETFs, as the com­pany has been a big driver of get­ting in­vestors’ fees down. We like also to watch Van­guard’s fund flows, as it has a huge in­di­vid­ual re­tail in­vestor base. Once again (as it has for more than a decade) Van­guard re­ported net fund in­flows in Oc­to­ber. It is al­ways hard to get a bear mar­ket rolling if money con­tin­ues to pour into the mar­ket.

5) Buf­fett is still buy­ing

War­ren Buf­fett bought back close to US$1 bil­lion in shares in his Berk­shire Hath­away hold­ing com­pany in Au­gust, and the com­pany fi­nally made a dent in its gi­ant cash hoard (still US$243 bil­lion!).

We haven’t seen his Oc­to­ber buy­ing num­bers, but, as in 2008, when Mr. Buf­fett came in with US$5 bil­lion to sup­port Gold­man Sachs while the fi­nan­cial world was im­plod­ing, he likes to buy when oth­ers are sell­ing, and his tim­ing is far more right than wrong. In­vestors could do worse than fol­low­ing his lead.

Even with Oc­to­ber’s swoon, all U.S. in­dices are now up on the year, re­cov­er­ing nicely. Looks like it could be time for a Santa Claus rally.

CHRISTO­PHER GOODNEY/BLOOMBERG FILES

Though we haven’t seen his Oc­to­ber buy­ing num­bers yet, Berk­shire’s War­ren Buf­fett likes to buy when oth­ers are sell­ing. Since his tim­ing is far more right than wrong, in­vestors could do worse than fol­low his lead, writes Peter Hod­son.

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